Colander ch07 taxesgovtintervention

Taxation and Government Intervention Chapter Taxation and Government • For government to provide goods and services such as national defense, social security, national parks, etc it must have money • The Government raises money several ways including user fees and taxes • User Fees are fees paid by those that use the good or service: it is a price • Taxes may be paid by everyone or only those that use a good or service: who pays depends on the type of tax Types of Taxes • There are many types of taxes: – – – – – – – Personal Income taxes Corporate Income taxes Excise Taxes Value Added Taxes (VAT) Property Taxes Social Security Taxes Sales Taxes Tax Burden or Incidence • Who seems to pay the tax and who actually pays the tax may not be the same person! • For example, suppose the federal government institutes a 10% excise tax on luxury boats • Suppose the consumer pays the tax up front: on the purchase of a $100,000 luxury boat the consumer pays sales taxes of 5% and a luxury tax of 10% for a total price of $115,000 (there is no tax on tax) • But what if the boat builder had to lower the price from $110,000 to $100,000 to sell the boat? • In this case, the buyer appears to pay the luxury tax but in reality the boat builder pays the taxes • The entire burden of the tax falls on the boat builder What is the Role of Government? • The level of taxes is determined by the amount of government services and goods provided • The Government’s roles include: Providing a stable set of institutions, laws and rules Promoting effective and workable competition Correcting for externalities Creating an environment that fosters economic stability and growth – Providing public goods – Adjusting for undesirable market results – – – – The How Much Should Government Tax? • The government must raise revenues equal to the cost of providing the amount of goods and services that its citizens demand The Costs of Taxation • The costs of taxation include: – The direct cost of the revenue paid to government – The loss of consumer and producer surplus caused by the tax – The cost of administering the tax codes The Costs of Taxation • When government institutes taxes, there is a loss of consumer and producer surplus that is not gained by government • This is known as deadweight loss The Costs of Taxation • Graphically the deadweight loss is shown on a supply-demand curve as the welfare loss triangle • The welfare loss triangle – a geometric representation of the welfare loss in terms of misallocated resources caused by a deviation from a supply-demand equilibrium Consumer Surplus Producer Surplus • Consumer Surplus – the amount of consumers would be willing to pay (with perfect price discrimination) minus what they have to pay (at the market price) is the excess benefit consumers enjoy and is called consumer surplus • Producer Surplus – the amount producers receive for the total units sold (at the market price) minus what they would have received if they charged their cost for each unit • See pages 97-99 and page 158 for more info (in hardback Economics text) End of Chapter in Microeconomics book Inelastic Demand and Incentives to Restrict Supply • When demand is inelastic, producers have incentives to restrict supply • Farming is an example Inelastic Demand and Incentives to Restrict Supply • Advances in farming productivity increases supply but lowers prices • Since food has few substitutes, its demand is inelastic • Inelastic demand means that prices fall faster than a rise in quantity sold • Revenues fall, and farmers are worse off Inelastic Demand and Incentives to Restrict Supply • There is an enormous incentive for farmers to seek a price floor from government or through a producer cooperative Inelastic Demand and Incentives to Restrict Supply Price S0 P0 S1 Revenue Lost Revenue Gained P1 Total Revenue Demand Q0 Q1 Quantity Inelastic Supply and Incentives to Restrict Prices • Consumers are also rent seekers not just businesses • When supply is inelastic, consumers have incentives to restrict prices Inelastic Supply and Incentives to Restrict Prices • When supply is inelastic and demand goes up, prices jump causing consumers to lobby for price controls • Rent control in New York City is an example Price Floors and Elasticity of Demand and Supply Price floor with elastic supply and demand Price Supply PF PE Demand QD QS Quantity Price Floors and Elasticity of Demand and Supply Price floor with elastic supply and inelastic demand Price Supply PF PE Demand QD QS Quantity Price Floors and Elasticity of Demand and Supply Price floor with inelastic supply and demand Price Demand Supply PF PE QD QS Quantity The Long-Run/Short-Run Problem of Price Controls • The problem of price controls worsen from the short run to the long run • In the long run, supply and demand tend to be much more elastic than in the short run The Long-Run/Short-Run Problem of Price Controls • So in the short run there will be small effects from the price controls, but huge effects in the long run The Long-Run/Short-Run Problem of Price Controls • In the face of price controls, potential new competitors hate to enter the market thereby strangling supply • Vacancy rates drop as potential new renters scramble to find shrinking affordable housing Long-Run and Short-Run Effects of Price Controls Price Short run supply P1 P2 P0 Long run supply Price ceiling D1 D0 Q0 Q1 Q2 Q3 Shortage Quantity Taxation and Government Intervention End of Chapter